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Balance Sheet - Accounting for Fixed Assets - Depreciation

The concept of depreciation of fixed assets is a fairly simple one for suitably accountants, booker keepers, finance directors and accounting students but often remains a mystery for non finance people. Moreover, because more and more businesses rely on accounting software which automates many transactions, including depreciation, even some finance people may not be fully aware of the exact bookkeeping entries involved.

Most assets in a business depreciate or reduce in value over time, through consumption or simple market value. Accounting practice seeks to recognize this and to decrease their value on the balance sheet over an estimated period of time equivalent to the useful life of the asset and at the same recognize the consumption of that asset by creating an expense in the profit and loss account during each accounting period during the life of the asset as the contra entry. As the fixed asset value is decreased so also the expense account is increased.

For example let us say we buy an asset for £9,000 and we expect it last 3 years. We will use straight line depreciation methods (there are others but this is simplest and most commonly used). This means that we will write down the value of the asset by £3000 per year and create a charge for the same amount.

When the asset is purchased it will be recorded as a Fixed asset on the balance (and not as a profit and loss item). The book keeping journal would be something like:-

Debit Fixed assets £9000

Credit Cash £9000

After the first year the asset will have been depreciation by £3000 and the accounting method used (so as not to lose sight of the asset's original value) is to create a provision thus:-

Credit Provision for depreciation £3000

Debit profit and loss account £3000

The balance sheet presentation will then show the gross (original) value of the asset and also the accumulation depreciation provision effective showing the net book value (i.e. reduced value) of the asset thus:

Balance Sheet XYZ Limited

Fixed assets at cost £9000

Accumulated Depreciation £3000

Net Book value £6000

As referred to above there are several methods to calculation depreciation of fixed assets. The most common method of depreciation is the straight-line method as used in our example. The straight-line depreciation method allows for equal deprecation over the life of the asset. Straight-line depreciation is also the easiest method of depreciation to calculate.

There are also various so called accelerated methods that allow for larger depreciation amounts in the early life of the asset. Accelerated methods are especially useful for income producing assets that produce more income during the early life of the asset. Some of the more common methods are sum o the years digits and the double declining balance methods.